Square’s Found a Way to Beat Banks at the Loan Business

Using a cash advance from Square Capital, Cafe Grumpy opened a sixth location in New York's Grand Central Station. Photo: Square

Square’s motto is “make commerce easy.” For the past four years, this was embodied in its eponymous credit card reader, which lets merchants ring up sales via their smartphones and tablets. But today, the company is diversifying in a dramatic way: Instead of merely processing payments, Square also will provide a way for merchants to inject extra cash into their businesses–no loan application required.

The program, called Square Capital, offers cash advances in exchange for a cut of future sales. It’s available to merchants already using Square’s Register app, which oversees use of its card reader. Businesses can’t apply for these advances, but if they need it, Square may offer one out of the blue. The company uses the massive trove of payments data it collects to algorithmically decide who’s offered an advance, how much they’re offered, and how much interest they’ll pay for it.

Square extends these offers via email or through the web-based Square dashboard where merchants track customer credit card payments, and the advances are paid back through the company’s credit card services. Instead of asking for a fixed regular payment, Square takes a percentage of a merchant’s daily credit card sales, with no time limit for paying off the advance. As described by the company, Square Capital is about Square finding one more way to render the red tape of traditional banking obsolete. “We feel that what Square Capital is doing for access to capital is analogous to what Square did four years ago for card processing,” says Gokul Rajaram, Square’s head of product. “Card acceptance four years ago was equally not transparent, slow, bureaucratic, and not flexible.”

The move is just one way some of the world’s web companies are transforming themselves into operations that behave much like banks. Companies from Square to Alibaba are not only helping you handle money, they’re helping you store it and, in some cases, borrow it.

The move is just one way some of the world’s web companies are transforming themselves into operations that behave much like banks.

To show the benefits of Square Capital, Rajaram pointed to Caroline Bell, owner of Café Grumpy. She used an early version of the service to grab the money she needed to open her sixth location, in New York’s Grand Central Station. Bell told WIRED that in the past, she spent six months on paperwork to get a traditional loan. Square Capital delivered in about a day. “You get cash quickly and you don’t have to think about it anymore,” she said.

Of course, any promise of easy money raises suspicions, and in some ways, Square Capital feels like it veers close to payday-lending territory. In part, the money from Square Capital is easier to come by than a traditional loan because it’s not a loan at all. It’s a “merchant cash advance,” in which a business pledges a cut of future sales in exchange for cash now. Ironically, the better a business does, the more expensive the advance is. If sales boom and a shop pays back its advance in six months, for example, the 10 percent it’s paying on top becomes a 20 percent annual rate. Repaying the advance faster makes the money more costly compared to fixed payments.

But Rajaram contends that the flexibility of Square Capital is key, especially for small businesses. Cash flow can be unpredictable, he says. Because repayments are taken as a percentage cut rather than a fixed amount, businesses need never stretch to make a payment. Typically, Square anticipates repayments should take about 10 months, a time frame over which in theory it has extensive control. That’s because, according to Square, it can tightly tailor the terms of each advance to each business. As the payment processor, Square has an intimate understanding of each merchant’s cash flow, growth rate, and finances, Rajaram says. “We have a holistic sense of your business.”

If Square is living up to the ideal standards of its mission statement, it will seek to optimize its advances to what merchants can readily manage, not what they can barely afford. Considering recent attention on the health of Square’s own finances, Silicon Valley will be watching to see how businesses take to Square Capital and whether it can become an important new way for Square to make money.

As different as cash advances may seem, however, Square Capital in the end is a natural extension of its core credit card business. One of Square’s strongest selling points is its quick turnaround. Square promises that payments taken one day generally will be deposited in a business’s bank account by the next, regardless of size. To meet that promise, Square often is shifting the risk from merchants to itself that any given payment will go through, a risk it feels comfortable taking thanks to the confidence it has in the predictive algorithms it’s developed to assess the likelihood of actually getting paid.

It’s that same machine intelligence Square is leveraging to advance capital through Square Capital, in amounts up to the tens of thousands so far, for a total of tens of millions. If the program is successful, that amount could jump quickly. In the process, Square may show that its real value as a company is not in its card readers, but in its code.